China prepares retaliatory measures as trade war deepens 

On 29 August China’s Ministry of Commerce (MOFCOM) emphasised China’s willingness to continue negotiations with the US to avoid further escalation of the bilateral trade war.

Hope not expectation

MOFCOM spokesman Gao Feng said that escalation will benefit neither side and “the most important thing is to create the necessary conditions for continuing negotiations”. His comments were interpreted optimistically by many observers, briefly appearing to boost financial markets. Despite two rounds of tit-for-tat tariff announcements in August, US and Chinese negotiators are still in contact, with talks in the US tentatively scheduled for early September. However, both sides’ positions have hardened in recent months and it is not clear that either is offering significant new concessions. Even if cabinet-level talks go ahead in September, key differences are unlikely to be overcome without intervention by US President Donald Trump or Chinese President Xi Jinping.

As the trade war’s impact on the US economy becomes more visible in the coming months, Trump may show renewed appetite for compromise in order to reach a deal. However, it is unclear whether he will view a deal as positive or negative for his re-election prospects in 2020, while Xi is unlikely to go significantly beyond the concessions China has already offered. While both leaders will continue to have strong reasons to seek respite, companies must plan based on the assumption that US-China frictions will continue to create an uncertain and disrupted business environment in 2020 and beyond.

Regulating reliability

If – or more likely, when – talks falter, further escalatory moves by the US are likely to see China retaliate with more than just tariffs. For several months Beijing has been preparing the regulatory tools to respond to various non-tariff tactics which the US already used against China in 2018-19, particularly those targeting individual Chinese companies (such as in the telecommunications and semiconductor sectors). One of these Chinese tools is the UEL. It was first announced by MOFCOM on 31 May but neither the list, nor details of when and how it will be implemented, have yet been released.

A 22 August headline in China’s state-linked Global Times newspaper said that the UEL was “imminent”. However, MOFCOM has repeatedly stated since May that the list would be issued “soon”, and this language has not changed in MOFCOM’s statements released in August. Gao’s 29 August comments also suggest that “imminent” may be a misleading word choice – this would be unsurprising given the Global Times’ tendency to adopt a tabloid style and nationalist tone. Nonetheless, proceeding with the UEL is likely to be part of China’s response should the US take major escalatory actions in the coming weeks or months.

The UEL is a response to the US using the Commerce Department’s long-standing Entities List to place restrictions on major Chinese companies, including export control with the potential to cripple those companies’ operations. It is also a clear warning that China will directly target foreign companies that cut ties with Chinese firms to comply with US restrictions. MOFCOM has stated that companies can be listed if they:

• Block supplies or take other discriminatory measures against Chinese entities.
• Act for non-commercial reasons, against market rules or the spirit of contracts.
• Damage the legitimate interests of Chinese enterprises or related industries.
• Take actions that constitute a threat to China's national security.

However, the UEL is just one of several developments. This looming regulatory focus is combined with rising “patriotic” scrutiny of multinationals by government, media and the public, heightening multiple risks to businesses in China.

List looms

The delay in releasing and implementing the list may be due partly to the bureaucratic practicalities of preparing and approving such a contentious measure. But it probably also reflects that China has been holding back – hoping for leverage in talks, and in no rush to go through with actions that it knows will further unnerve foreign investors.

At this stage it is only possible to speculate exactly how and when the UEL will be implemented, but Beijing is likely to do so very selectively at first: initially, it might only list a small number of companies, focusing on those Beijing deems to have taken some particularly harmful action or to have particular symbolic significance. Alternatively, it might list many firms but apply only limited, deferred or vague consequences. For example, it could warn Chinese companies about certain relationships with listed entities without enforcing any broad ban. It is unclear whether penalties will focus on “reliability” by requiring Chinese firms in some industries to reduce their use of listed suppliers, or if they might mirror US rules by also restricting Chinese companies’ sales to the listed entities.

Given the scope for self-inflicted damage, China is unlikely to totally cut off market access or aggressively target every company that complies with the US Entities List requirements (which can also affect non-US firms selling products with significant US content). But it would be a mistake to think Beijing is bluffing. It is preparing to take retaliation to a new level, and companies should take this very seriously.

Wider problem

The UEL ties in with other recent regulatory developments portending much wider scrutiny of foreign firms – or Chinese firms’ use of their products – on the grounds of “reliability” and national security concerns. The Cyberspace Administration of China (CAC) is planning cybersecurity reviews that will consider whether critical information infrastructure (CII) operators are vulnerable to supply disruptions due to “political, diplomatic and trade” reasons. Emerging rules to scrutinise other areas include the “Cybersecurity Review Measures”, “Data Security Administrative Measures” and the “Measures for Security Assessment of Cross-border Data Transfer of Personal Information”.

Together with existing uncertainty about how the Cybersecurity Law (CSL) will be implemented, CAC and other regulators are set to tighten enforcement in many areas, also including the collection, storage or transfer of data deemed “important information” – a grey area that involves national security but is broadly defined to potentially include a wide range of primarily commercial data.

The National Development and Reform Commission (NDRC) in April was given responsibility for leading national security reviews of foreign investment. China has had national security review procedures for many years and the NDRC has long been heavily involved. However, officials are increasingly critical of the US citing national security grounds to target China, and a very vague article in China’s new Foreign Investment Law (FIL) suggests Beijing might respond on this front.

A partly UK-owned food and retail company in August said it had been instructed to seek national security review clearance in order to complete the acquisition of a Chinese state-owned company – this may be the first time such a review request has been made public. Separately, NDRC in June said it would launch a “national technology security management list system”. There has been little official clarification of what it will involve, besides the vague intention to “more effectively prevent and handle national security risks”. However, the basic concept seems to be technology export controls – another counterpoint to US actions.

Although China’s leadership is very concerned about the risk of exacerbating foreign companies’ loss of confidence in China’s business environment, this type of regulatory scrutiny is likely to be a feature of the coming year, with many companies increasingly squeezed between Chinese and US pressures.